Healthcare reform: Winners & losers

The Australian healthcare sector is being turned on its head. Which stocks will benefit, and which have the most to lose?

The Federal Government is hell-bent on reforming the healthcare sector.

Recent reviews of the system, such as the National Health and Hospitals Reform Commission (2009), Henry Tax Review (2010), Productivity Commission (2011), National Commission of Audit (2014) and Medicare Benefits Schedule Review (2016) have recommended significant changes to the funding and delivery of healthcare.

Several Government reforms are already underway and more will be progressively implemented over the next decade.

WINNER: Private health insurers

The crux of the problem is that Government healthcare spending has tripled over the past 30 years. Costs are growing well above inflation and things will only get worse as the population ages and the baby boomers enter retirement.

To relieve some of the pressure on the public healthcare system, the Government has employed various financial incentives and disincentives to funnel as many people as possible towards private health insurance, such as the private health insurance rebate and lifetime health cover loading. That should ensure private health insurers Medibank Private (ASX: MPL) and NIB (ASX: NIB) see plenty of growth in policyholders and revenue.

A Medicare review is currently underway to assess the prevalence of overuse in the healthcare system and find efficiencies. Insurers are pushing for the industry to shift from a fee-for-service payment model to ‘value-based’ reimbursements focused on patient outcomes, which is increasingly used in other countries with significant success. This would benefit insurers by reducing unnecessary claims.  

Finally – though far more controversially – the National Commission of Audit suggested the removal of ‘risk equalisation’, which is a form of cross subsidisation between insurers. This would favour NIB in particular as its younger member base ensures that it is the largest contributor to the funding pool. However, we expect significant opposition from the main beneficiaries of the status quo – namely Medibank – and don’t expect change any time soon.

WINNER: Private hospitals

Private hospital operators Ramsay Health Care (ASX: RHC) and Healthscope (ASX: HSO) also have the deck stacked in their favour as the Government is severely curtailing funding for public hospitals.

Following 2014 proposals, Commonwealth hospital funding increases will fall from 9% to 4.5% in July next year and ongoing increases will be linked to inflation and population growth.

In a recent interview with Fairfax Media, acting secretary of the Victorian Department of Health and Human Services, Kym Peake, said the $18bn to be cut from Victoria’s system alone ‘would equate to the level of service delivery of two health services the size of Melbourne Health,’ which runs Royal Melbourne Hospital.

Given that total public hospital funding Australia-wide will be cut by more than $50bn over the next decade, the Government will need to outsource more services to private operators, and we expect industry heavyweights Ramsay and Healthscope to take the lion’s share.

LOSER: Pathology and imaging

The Government’s Mid-Year Economic and Fiscal Outlook, which was released in December, included various Medicare fee cuts to lab and imaging services, as well as the removal of bulk-billing incentives for pathology services.

That’s bad news for Australia’s pathology duopoly, Sonic Healthcare (ASX: SHL) and Primary Health Care (ASX: PRY). Sonic estimates the changes would cause a $50m a year drop in revenue and reduce 2017’s earnings before interest, tax, depreciation and amortisation (EBITDA) by 5–6%.

We expect fee pressure to be a growing issue for Sonic and Primary, with growth likely to be anchored for some time. Sonic’s international operations, which account for 59% of revenue, provide much needed diversification, as does Primary’s network of GPs.

LOSER: Aged care providers

Residential aged care operators Japara Healthcare (ASX: JHC), Regis Healthcare (ASX: REG) and Estia Health (ASX: EHE) are in for a bumpy ride as Government funding gradually moves to a ‘consumer pays’ model.

In July 2014, the Living Longer, Living Better reforms allowed for new means testing arrangements, which will ensure that a growing share of the providers’ revenue is from resident contributions. As Government funding declines, however, alternatives to nursing homes, such as home care, become more viable.

The biggest threat, though, is that the Government has flagged potential deregulation of bedding licences by attaching subsidies to the consumer, rather than the residential aged care provider.

This could significantly increase the supply of places and reduce the industry’s barriers to entry. The proposal has support from both political parties and it makes sense from an efficiency and consumer choice standpoint, so we expect the reforms to eventually be enacted.

One way or another, increasing supply and competition in the residential aged care sector seems inevitable, which could offset the benefit of relentlessly growing demand from the aging population. There’s no free lunch here.

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